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1. Introduction
The purpose of this study is to investigate the relationships between accruals and initial management earnings forecast errors (MFERR), and between accruals and forecast revisions. In addition, consideration is paid to the economic costs associated with mandatory earnings forecasts for firms operating in uncertain business environments or facing difficulty in analyzing economic information.
Compared to current earnings, earnings forecasts have a greater effect on stock prices (Ota, 2010). As such, earnings forecasts are a critical information source in Japanese financial markets. Japanese financial market regulators strongly recommend all listed firms to disclose earnings forecasts for the coming fiscal year. Approximately 97 percent of listed firms comply with this recommendation, disclosing forecasts for year t+1 at the beginning of each fiscal year (Study Group on Earnings Reports, 2006).
While compliance rates are high, firms abiding by mandatory disclosure requirements typically incur substantial economic costs. These costs include a combination of litigation expenses and declining stock value – many investors consider forecasts to be representative of firm commitments; therefore, an inability to meet earnings forecasts suppresses stock value. This situation creates an incentive for firms to disclose management forecasts carefully to avoid downward revisions ( The Nikkei, 2007)[1]. However, the potential for an economic downside also creates an incentive for managers to seek opportunities to evade earnings forecast disclosure requirements. As a result, the Japan Business Federation is requesting the abolition of mandatory earnings forecast disclosures (Nippon Keizai-dantai Rengokai, 2010).
Evaluating the impact of mandatory earnings forecast disclosures requires an assessment of the effects of accounting information. Specifically, it is important to compare accruals (abnormal working capital accruals (ABWCA) and normal working capital accruals (NABWCA)) in year t with either the initial MFERR for year t+1 or the forecast revisions of the current fiscal year. This comparison assists in analyzing the degree to which accounting information affects management earnings forecasts. The Japanese financial market provides a comprehensive data set for assessing the relationship between accounting information and variations in earnings forecasts – almost all listed Japanese firms disclose earnings forecasts at the beginning of the fiscal year and many provide revised forecasts throughout the year.
In addition to assessing accounting information, earnings forecasting also requires knowledge of economic parameters (Penman, 2001; Palepu